Stocks corrected on Friday when the nonfarm payroll report showed a substantial slowing of the US labor market. With a large number of economic reports coming in weaker than expected in recent months, the big question on everyone’s mind right now is whether the US is heading into a recession and, if so, when?
If a US recession is imminent, we should expect to see a continued deterioration in the labor market. Just how fast unemployment picks up and the exact trajectory of the data is hard to predict, however we can do more than just track the data as it comes in; we can also look at leading indicators to see where the data is likely to head.
This chart comes from PFS Group’s Chris Puplava, which shows nonfarm payrolls in black and the percent of banks tightening on loans to small businesses in red (recessions denoted by vertical red bars).
The percent of banks tightening on loans to small businesses leads nonfarm payrolls by about 6 months since, as banks tighten, small businesses have difficulty funding their operations and layoff workers.
In the chart above we’ve advanced the percent of banks tightening forward by that amount to show the extremely high correlation between these two indicators overtime. Currently, the percent of banks tightening (inverted for directional similarity) shows the trend for nonfarm payrolls is expected to deteriorate in the quarters ahead.
When looking at the two prior market cycles, the current reading of banks tightening corresponds to the same level reached in 1999 and 2007.
It is possible that banks will loosen their standards towards the main engine of job growth in this country, in which case we would expect employment trends to stabilize or even pickup. At this point however, there is no denying that the trend is for continued deterioration in the unemployment outlook according to this very important forward-looking indicator.
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